Global Inflation: Improvement

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Rebecca Hardy
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1 Global Inflation: Improvement Despite 4 weaker-than-expected US CPI prints, TIPS outperformed their nominal counterparts by 24bps in July. Global linkers have also begun to perform in recent weeks, with exposure to FX enhancing returns this year. TIPS were supported by a rebound in oil and commodities, as well as by a dovish turn by the Fed The global economic backdrop continues to be supportive, with firm PMI prints pointing to manufacturing strength and reduced downside risks EM continues to perform well, supported by the combination of firmer commodities and a softer dollar, along with a slightly less hawkish Fed. Curb Your Expectations But Not Your Enthusiasm In last month s Dashboard, we wrote optimistically about the gains seen in the inflation markets over the latter part of June. The better tone continued through July, bolstered by rising oil and commodity prices and by a respite from the more hawkish rhetoric from the Fed and other central banks. Fed Chair Yellen set a more dovish tone in her semi-annual congressional testimony - partly in response to ongoing weakness in the inflation data - just days before the release of the June CPI data. While that report was once again a touch below economists expectations, there were some reasons for optimism going forward, not least of which were strong shelter prices and signs of a rebound in other core services (more below). TIPS breakevens imply that the recent softer trend in inflation is here to stay (5yr TIPS BEI ~1.70%). Given our expectation for CPI to rebound back toward 2% later this year, we would agree with the growing chorus of those who see the asset class as still fundamentally cheap. But our rationale for owning TIPS doesn t come from our faith in our inflation forecast alone, but rather the proven diversification benefit for owning TIPS in any portfolio: higher risk-adjusted returns. The case is stronger still for owning global inflation assets, along with EM, a subject we wrote about extensively last month and which we revisit briefly below. 1

2 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Commentary from New Century Advisors Black Gold, Texas Tea We are hesitant to extrapolate current strength too far into the future, but there is no question what the number one driver of recent TIPS returns has been: oil is up 16% since hitting a 14 month low in June. But while oil is fighting its way out from under a supply glut, it s not alone in the move higher. Copper, often seen as a global industrial bellweather, is at a more than 2yr high and is up 16% from its Q2 lows and 47% from its early 2016 lows. The S&P GSCI (commodity index) is up nearly 9% since its June lows. What has been driving oil higher lately? Much has been written about OPEC s production caps, installed to help reduce a global supply glut. Many expected rising US production to offset the OPEC cuts, and for a while it did, but the tide has since turned. As seen in the chart to the right, US crude inventories have not only dropped 10% from their highs this spring, they ve fallen below where they were at this time last year. This has come despite the release of >16mm bbl of oil from the SPR (Strategic Oil Reserve, sold to cover maintenance and upgrade costs). By most accounts, the global supply glut has fallen even faster. DOE Oil Inventories by Year (mm bbl) /1 2/1 3/1 4/1 5/1 6/1 7/1 8/1 9/1 10/1 11/1 12/ Source: DOE, Bloomberg, and NCA Why it matters: Average US retail gasoline prices have been rising since early July. The BLS (the keepers of the CPI) measure the average price over the entire Retail Gasoline (US avg $/gal) month. In July, AAA reported that the average price $2.50 for a gallon of gas was $2.27, down 1.75% from June but +~0.25% on a seasonally adjusted basis (pending $2.40 Friday s CPI report; gasoline prices usually decline in $2.30 the summer.) It is currently $2.35 and rising. If it $2.20 holds right here for the remainder of the month it $2.10 will be up over 3.5% MoM in August, but up 5.75% on a seasonal basis. With a 3.4% weighting within CPI,that s worth nearly 0.2% MoM for CPI, all by itself (+0.196%). That number only grows as gasoline Source: AAA, Bloomberg, and NCA continues to rise. 2

3 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Commentary from New Century Advisors Inflation Sanguinity While we do pay a lot of attention to the energy markets and do see further upside risks, our hair isn t particularly on fire about oil here. Overall, we continue to be rather sanguine on inflation in the medium term, both to the upside as well as to the downside. Here s why. The June CPI print released in July shows two trends that should comfort the Fed. First, Shelter, the 800lb gorilla in the index (33.3% of the total CPI), had its best print of the year, hotel prices notwithstanding. Rents rose 0.348% MoM in June, the most since October. Owner s Equivalent Rent, or OER, was % MoM, its biggest gain since December. Overall, Shelter rose 0.235% MoM in June, % YoY, down from its peak, 3.64% YoY in December. Hotel prices, aka Lodging Away From Home, continue to be a drag, falling 1.95% MoM in June and sliding into negative territory YoY Shelter Sub-Indices, YoY (down 0.05%). A bit more on that in a minute. 4.0% 10.0% Furthermore, Core Services Ex- Shelter, which took a hit this spring largely from cell phone Source: BLS 3.5% 3.0% 2.5% 2.0% and NCA plans but also from a return to trend from high Recreation and Transportation costs, look to be stabilizing and even picking back Rent, 7.85% Shelter, 33.3% OER, 24.5% LAFH, 0.92% (rhs) up. The chart on the next page shows annualized 3 month data for the various Core Services sub-indices going back a year and a half. As the drop in cell phone plans fades further into the past its impact wanes, an effect that can clearly be seen on the black line, which combines all the sub-indices (again, 3-month annualized). That appears headed for a convergence back with the green line, which is the 12-month version of the same. 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% 3

4 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Sep-16 Jan-17 May-17 Commentary from New Century Advisors Core Services (Ex-Shelter), 3mo Annualized 5% 0% -5% -10% Household operations, 0.85% Water, sewer & trash, 1.18% Other personal services, 1.63% Recreation services, 3.94% Transportation services, 5.96% Education and Communication, 6.17% Medical care services, 6.69% Total Core Services (Ex-Shelter) Total Core Services (Ex-Shelter, YoY) Source: BLS and NCA The Cyclical Five But, because there s always a but keep an eye on the cyclical five: Apparel, New & Used Cars, Airfares, and Hotels (Lodging Away from Home). These are highly consumer-driven sectors that represent 10.4% of the CPI, and they ve been in steady decline for years. Combined, they fell 1.32% YoY in June. While the analysis above alleviates our concerns about the downside risks to 16% 12% 8% 4% 0% -4% -8% Cyclical Five - YoY New Vehicles, 3.65% Used Cars and Trucks, 2.01% Apparel, 3.09% Airline Fares, 0.70% Lodging Away from Home, 0.96% Combined, 10.4% inflation, the weakness in the discretionary categories limits our concerns about the upside risks. Source: BLS and NCA 4

5 In Closing The outlook remains favorable both for TIPS and global inflation markets in general. After a few weakerthan-expected prints, US CPI is likely to stabilize and eventually rebound back towards 2%, making current TIPS valuations cheap. We continue to see opportunities overseas, including EM, and believe that inflation investors can benefit from global diversification. We remain ever vigilant on flows and market positioning, keeping a close eye on various measures of investor demand. Local Currency Return Local BEI Return July YTD July YTD Australia -0.16% 1.66% -0.27% -0.84% Italy 0.95% -0.59% 0.37% -0.21% Canada -3.24% -3.40% 0.14% -2.57% Spain 0.54% 1.41% 0.25% 0.52% France 0.75% -0.89% 0.58% -0.41% Denmark 0.60% -0.09% 0.33% 0.13% Germany 0.59% -2.44% 0.62% -0.58% Japan -0.38% -1.75% -0.40% -1.59% New Zealand -0.66% 3.21% -1.09% -0.54% Sweden 0.18% -0.55% 0.44% 0.36% UK -1.38% -1.93% -1.61% -2.44% US 0.42% 1.37% 0.24% -1.15% WGILB -0.14% -0.19% -0.27% -1.40% 5

6 For more information on any of the data, trends, or trading strategies in this piece, or to discuss how New Century Advisors might help you to manage your inflation risk, please contact Leigh Talbot, CFA, Director of Client Relations at and Important Disclosures: Forward looking statements: Any projections, forecasts and estimates contained herein are forward looking statements and are based upon certain assumptions that New Century Advisors considers reasonable. Projections are necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the projections will not materialize or will vary significantly from actual results. Accordingly, the projections are only an estimate. Actual results may vary from the projections, and the variations may be material. Some important factors that could cause actual results to differ materially from those in any forward looking statements include changes in interest rates, market, financial or legal uncertainties, the timing of acquisitions of the underlying assets, the timing and frequency of defaults on the underlying assets, amongst others. Consequently, the inclusion of projections herein should not be regarded as a representation by the manager of the results that will actually be achieved. New Century Advisors, LLC has no obligation to update or otherwise revise any projections, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of unanticipated events, even if the underlying assumptions do not come to fruition. The securities listed in New Perspectives are not to be considered recommendations or an offer to buy or sell securities and are being used as illustrations only. Past performance is not an indicator of future results. There is no guarantee that the investment objective of the strategy will be achieved. Index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. One cannot invest directly in an index. CLIENTS MUST BE PREPARED TO BEAR THE RISK OF A TOTAL LOSS OF THEIR INVESTMENT. THE THEMES AND STRATEGIES HEREIN ARE NOT TO BE CONSTRUED AS RECOMMENDATIONS. THEY ARE FOR ILLUSTRATION PURPOSES ONLY AND SUBJECT TO CHANGE WITHOUT NOTICE. Data provided by New Century Advisors, LLC, Bloomberg and BLS. NCA does not guarantee or warrant the accuracy, timeliness, or completeness of third party provided information and is not responsible for any errors or omissions. The discussion of any investments in this presentation is for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments identified and described do not represent all of the investments purchased or sold for client accounts. The representative investments discussed were selected based on a number of factors including, investment process and subject matter applicability. The reader should not assume that an investment identified was or will be profitable. 6

7 The information contained in this or document may not be reproduced or provided to others without the prior written permission of New Century Advisors, LLC. The information provided is neither an offering nor a solicitation of an offering for any securities. Nothing contained herein shall constitute any representation or warranty as to future performance. 7

Commentary from New Century Advisors January 2019

Commentary from New Century Advisors January 2019 NCA MARKET NOTES Residual Inflation Sensitivity Oil Services Not Participating in the Production Boom Looming Fed Pause and Key Investment Themes INFLATION CORNER: Residual Inflation Seasonality While